Robert D. Cooter & Neil S. Siegel. October 17, 2011 ABSTRACT

Transcription

1 TAXES, PENALTIES, AND THE MINIMUM COVERAGE PROVISION Robert D. Cooter & Neil S. Siegel October 17, 2011 ABSTRACT Article I, Section 8 of the U.S. Constitution explicitly gives Congress the power to regulate interstate commerce and to promote the general welfare by taxing and spending. Most judges and scholars conclude that Congress s power to regulate is narrower than its power to tax, but they have not developed a theory to distinguish between taxing and regulating. We develop such a theory by analyzing the Constitution s history and text in light of modern economics. Penalties coerce more than taxes, and economics explains why. A pure tax is an exaction on permitted behavior, so it raises revenues and dampens behavior without preventing or condemning it. Examples include tariffs, excises, head taxes, property taxes, income taxes, and pollution taxes. Congress has the constitutional power to impose pure taxes to promote the general welfare. In contrast, a pure penalty is an exaction on forbidden behavior. A pure penalty condemns behavior and prevents it, which undermines raising revenues. Condemnation comes from moral language such as penalty, wrongdoing, and punishment. Prevention comes from exactions that are higher than the gain of actors from engaging in the conduct, so wrongdoers suffer a net loss. Examples include criminal fines and punitive damages in civil cases. Prevention also comes from increasing the exaction s severity for intentional or repeated violations to make wrongdoers relent, as with enhancements to criminal punishments. According to longstanding doctrine, Congress has the constitutional power to impose pure penalties in order to regulate interstate commerce but not to promote the general welfare. In between pure taxes and pure penalties lie exactions like the minimum coverage provision in the Affordable Care Act, which imposes a fee on applicable individuals who fail to obtain health insurance coverage. The ACA calls this exaction a penalty, which sounds like condemning wrongdoing. But the exaction is not higher than the cost of private insurance and it does not increase with intentionality or recidivism. Because the fee s material characteristics do not prevent people from going without private insurance, it works like a tax on permitted behavior. Tax equivalent is our phrase for a statute that sounds like a regulation but works like a tax. When interpreting exactions under the General Welfare Clause, materiality should outweigh expression, as the U.S. Supreme Court has long concluded. Thus an exaction like the ACA s minimum coverage provision is properly categorized as a tax. 1

2 TAXES, PENALTIES, AND THE MINIMUM COVERAGE PROVISION Robert D. Cooter & Neil S. Siegel ** CONTENTS Introduction...2 I. History...9 A. Pre-Ratification...9 B. Post-Ratification...13 II. Doctrine...17 A. Three Eras...17 B. Discussion...24 III. Theory...26 IV. Application...35 Conclusion...43 The difficulty of saying when the power to lay uniform taxes is curtailed, because its use brings a result beyond the direct legislative power of Congress, has given rise to diverse decisions. In that area of abstract ideas, a final definition of the line between state and federal power has baffled judges and legislators. 1 INTRODUCTION Article I, Section 8, of the United States Constitution begins with the General Welfare Clause, which grants Congress the power to lay and collect Taxes... to pay the Debts and provide for the common Defense and general Welfare of the United States. 2 The Framers placed the tax power first in the enumerated list for a reason. Authorizing Congress to tax individuals to fund the federal government solved the most significant collective action problem Herman Selvin Professor of Law, University of California at Berkeley. ** Professor of Law and Political Science, Duke University School of Law. We thank Jack Balkin, Josh Chafetz, Michael Dorf, R. Craig Green, Bernadette Meyler, Gillian Metzger, Lawrence Zelenak, and workshop participants at Cornell Law School for instructive conversations. 1 United States v. Kahriger, 345 U.S. 22, 29 (1953). 2 U.S. CONST. art. I, 8, cl. 1. 2

3 facing the states during the 1780s. 3 Federal taxation of individuals would succeed where requisitioning the states for their fair share of contributions to the national treasury had failed. In the Critical Period, the states acted individually when they needed to act collectively, free riding on the contributions of other states to the federal treasury. 4 Confederation denied Congress any power to solve this problem. 5 Moreover, the Articles of With no authority to tax, Congress had little money to spend. The Revolutionary War debts remained unpaid. 6 Congress was thus unable to meet the existential threats facing the young nation. National security demanded federal borrowing from other nations during wartime and timely repayment of the debts incurred. 7 Paying off debts requires revenue. Giving Congress the power to tax individuals to pay the Debts... of the United States 8 solved the problem. The Framers correctly anticipated that the revenue needs of the new government would be met by federal levies on imports. 9 3 See, e.g., W. ELLIOT BROWNLEE, FEDERAL TAXATION IN AMERICA (2d ed. 2004) ( The Constitution reflected the desire of James Madison, Alexander Hamilton, and its other leading supporters to provide the new central government with far greater capacity to tax than the old national government had enjoyed under the Articles of Confederation. The protracted political crisis of the 1780s convinced Madison and Hamilton that the new representative government must have the fiscal power required to create a strong and meaningful nation. ); Akhil Amar, The Lawfulness of Health-Care Reform, 12- YALE L.J. ONLINE (forthcoming 2011) ( A primary goal (indeed, perhaps the single most important and frequently expressed goal) of the Federalist Founders was to empower the federal government to impose taxes upon individuals to finance basic federal functions.... ). 4 See, e.g., Robert D. Cooter & Neil S. Siegel, Collective Action Federalism: A General Theory of Article I, Section 8, 63 STAN. L. REV. 115, (2010). 5 See, e.g., JACK N. RAKOVE, ORIGINAL MEANINGS: POLITICS AND IDEAS IN THE MAKING OF THE CONSTITUTION 24 28, 47 48, , , (1996) (discussing various failures of the Articles of Confederation). Almost all of the first thirty-six essays in The Federalist detail the inadequacies of the Articles. 6 See generally CALVIN H. JOHNSON, RIGHTEOUS ANGER AT THE WICKED STATES: THE MEANING OF THE FOUNDERS CONSTITUTION (2005) (arguing that the most pressing need at the time the Constitution was created was to allow the federal government to tax in order to pay off the Revolutionary War debts). 7 AKHIL REED AMAR, AMERICA S CONSTITUTION: A BIOGRAPHY 107 (2005) ( Without the ability first to borrow money from abroad when war threatened and then to pay back the loans on time... America would become a tempting target for European empires lusting after dominion. ); BROWNLEE, supra note 3, at ( A central goal was to fund the foreign debts that the Confederation had inherited from the Revolutionary War, and to do so in a way that would win the confidence of the international financial markets to which the new nation would have to turn for capital. ). 8 U.S. CONST. art. I, 8, cl AMAR, supra note 7, at 94 ( The big money would likely flow and after 1789 did in fact flow from federal levies on imports.... ); Rakove, supra note 5, at 180 ( [T]he framers believed that its revenue needs would 3

4 The Framers, however, did not limit the tax power of Congress to the repayment of debts. Rather than earmark federal revenues to past debts, the Constitution also gives Congress the power to tax in order to provide for the common Defense and general Welfare. Congress thus possesses the plenary power to tax, 10 and the constitutional text suggests that it may use this power to accomplish at least some regulatory objectives that advance the general Welfare. 11 For example, the Framers believed that import duties would not only raise revenue, but would also accomplish their goal of dampening imports and boosting domestic production. 12 While Congress may tax for some regulatory purposes, like dampening imports, neither the text of the Constitution nor its history identifies the limit of the regulatory objectives that Congress may pursue using its tax power. In addition, the Supreme Court of the United States has offered suggestive but ultimately problematic guidance for distinguishing between a permissible tax and an impermissible regulation or penalty under the General Welfare Clause. When is a federal exaction a tax and thus within the scope of the tax power, and when is it a penalty and thus beyond the scope of the tax power? The U.S. Reports do not offer a persuasive or even identifiable analytical distinction between them. The reason for this unsettled state of affairs is straightforward. If the Court seeks to limit the power of Congress to regulate under the Commerce Clause, the Court needs to prevent Congress from evading its restrictions on regulations by calling them taxes and justifying them under the General Welfare Clause. The Lochner Court imposed significant limits on the power be met through a program of indirect taxation centering on import duties.... ); BROWNLEE, supra note 3, at 21 ( Tariffs, in fact, turned out to provide the core of federal finance. ). 10 Rakove, supra note 5, at 180 ( But [the Framers] balked at limiting its revenue to that source alone. The only restriction placed on the discretion of the legislature was to prohibit it from laying duties on exports. ); JOHNSON, supra note 6, at 89 ( [T]he Constitution gives Congress the absolute power to tax. ). 11 U.S. CONST. art. I, 8, cl See, e.g., BROWNLEE, supra note 3, at 22 (discussing Hamilton s 1791 Report on Manufactures to Congress). For further discussion, see infra Part I. 4

5 of Congress to regulate under the Commerce Clause. 13 To preserve those limits, it also imposed a distinction between revenue-raising taxes and regulatory exactions. 14 This distinction does not work, however, in light of the many exactions throughout American history that have served both purposes. 15 Before the Court had to confront and resolve this problem, it rejected the Lochner Era restrictions on regulation. The post-lochner Court had no need to overrule prior decisions distinguishing regulations and taxes so long as it did not impose any limits on the scope of the commerce power. In the Supreme Court s words, the diverse decisions in this area of abstract ideas show that the difference between a tax and a penalty has baffled judges and legislators. 16 The problem went unresolved because it did not have to be and resolving it was difficult. In 1995, however, the Court began to restrict congressional power under the Commerce Clause. 17 Such restrictions create pressure to distinguish regulations and taxes. The Supreme Court, however, has yet to consider the constitutional scope of the tax power in the wake of its new federalism decisions. As a result, lower federal courts have little guidance in the current litigation over the minimum coverage provision in the Affordable Care Act (ACA). 18 Litigants and judges have drawn selectively from the different eras of the Court s tax power jurisprudence, 13 See, e.g., Carter v. Carter Coal Co., 298 U.S. 238, (1936) (invalidating the Bituminous Coal Conservation Act of 1935 because federal regulation of wages and hours concerned production, not commerce); A.L.A. Schecter Poultry Corp. v. United States, 295 U.S. 495, 546 (1935) (invalidating the Live Poultry Code for New York City, which regulated the sale of sick chickens and which included wages, hours, and child-labor provisions, based on an indirect relationship to interstate commerce); United States v. E.C. Knight Co., 156 U.S. 1, (1895) (holding that the Sherman Antitrust Act could not be used to thwart a monopoly in the sugar refining industry because the commerce power did not authorize Congress to regulate manufacturing, which was antecedent to commerce). 14 See Bailey v. Drexel Furniture Co., 259 U.S. 20, 38 (1922) (Child Labor Tax Case). 15 For numerous examples in addition to the impost, see infra Part I. 16 United States v. Kahriger, 345 U.S. 22, 29 (1953). 17 See United States v. Lopez, 514 U.S. 549 (1995); U.S. v. Morrison, 529 U.S. 598 (2000). 18 Public L. No , 124 Stat. 119 (2010); see Health Care and Education Reconciliation Act of 2010, Pub. L. No , 124 Stat (2010). 5

6 and they have mostly disputed the relevance of the fact that Congress labeled the exaction on the insured a penalty and not a tax. 19 Theory helps to answer significant constitutional questions when existing doctrine does not. This Article identifies the key differences between regulation and taxation as those concepts are used in Article I, Section 8. The expressive characteristics of an exaction concern the language used to describe it. With penalties, the language expresses condemnation. In contrast, the material characteristics of an exaction concern the conditions under which a person must pay a given amount. To prevent wrongdoing, penalties should be set higher than the usual actor s gain. To avoid a net loss, most people will avoid wrongdoing. For unusual people who do wrong intentionally or repeatedly, the penalty s severity should increase until the wrongdoer relents. An exaction that condemns and prevents wrongdoing is a pure penalty. Condemnation and prevention make pure penalties relatively coercive. Examples include criminal fines and punitive damages in civil cases. Pure penalties raise revenues only when they fail to prevent wrongdoing. According to longstanding doctrine, Congress has the constitutional power to impose pure penalties in order to regulate interstate commerce but not to promote the general welfare. By contrast, the language of a tax does not express condemnation. The absence of condemnation is often taken as permission. The material characteristics of a tax dampen behavior without preventing it. Behavior is not prevented because the tax is not higher than the usual actor s gain from the taxed conduct. Further tax rates do not increase with intentional or repeated activity. By not preventing the taxed behavior, taxes raise revenues. Dampening the 19 For a discussion, see infra Part IV. 6

7 taxed behavior is an undesirable byproduct for some taxes like the income tax, and a desirable goal of other taxes like a pollution tax. An exaction that permits and dampens is a pure tax. Permission and dampening make pure taxes less coercive than pure penalties. Examples include tariffs, excises, head taxes, property taxes, income taxes, and pollution taxes. According to longstanding doctrine, Congress has the constitutional power to impose pure taxes in order to promote the general welfare. Situated between pure taxes and pure penalties are exactions that use language condemning the conduct at issue and impose relatively modest, flat fees for engaging in it. The expression sounds like a penalty and the material characteristics look like a tax. Thus the ACA requires most people to obtain minimum health insurance coverage or pay a penalty. This is language for condemning wrongdoing, and its use explains why courts have resisted upholding the ACA under the tax power. The level of the exaction, however, does not exceed the cost of buying insurance and its flat rate does not change with intentionality or recidivism. These are the material characteristics of a tax. When people decide whether to buy health insurance or pay the penalty, most of them will presumably respond to the exaction s material characteristics, not its expression in words. So the ACA will work like a tax. Tax equivalent is our phrase for a statute that sounds like a penalty and works like a tax. Tax equivalents are confusing legally because their expression points towards regulations and the Commerce Clause, whereas their material characteristics point towards taxes and the General Welfare Clause. Legislators, however, have their own reasons for drafting exactions as tax equivalents, rather than as a pure regulation or a pure tax. When a statute contains a tax equivalent, should courts interpret it as a regulation or as a tax for purposes of the tax power? 7

8 For the Constitution to channel behavior, materiality must outweigh expression in classifying exactions, as the Supreme Court has long insisted. 20 An exaction like the minimum coverage provision, which sounds like a penalty but works like a tax, is most appropriately categorized as a tax. 21 Part I, on history, first recounts why supporters of the Constitution placed great importance on the tax power. Part I then identifies the purposes of federal taxes throughout American history. Part II, on doctrine, distinguishes three eras of the Court s jurisprudence on the tax power to help differentiate a tax from a penalty. Part III, on theory, offer an economic analysis of the material equivalences and differences between taxes and penalties. Part IV, on health care, applies our analysis to the debate over the constitutionality of the minimum coverage provision in the ACA. 22 The Conclusion connects the argument presented here to our theory of collective action federalism See infra Part II (discussing the U.S. Supreme Court s tax power jurisprudence). 21 In this Article, we limit our analysis to the distinction between a tax and a penalty under the General Welfare Clause. We do not analyze the distinction between taxes and fees under the Export Clause, U.S. CONST. art. 1, 9, cl. 5, nor do we analyze the distinction in the constitutional context of intergovernmental tax immunity. Finally, we do not analyze the distinction between a tax and a penalty in various federal statutes, including the federal tax Anti-Injunction Act, 26 U.S.C. 7421(a) (2006), the Tax Injunction Act, 28 U.S.C. 1341, or the Bankruptcy Act, 11 U.S.C (2006). These constitutional and statutory settings implicate context-specific questions that we cannot attempt to address here. 22 Although the unsettled constitutional distinction between a tax and a penalty under the General Welfare Clause is implicated in the constitutional litigation over the minimum coverage provision in the ACA, the Court s decision seems unlikely to settle the matter for at least two reasons. First, the Court will not reach the merits of the tax power question if it decides that the federal tax Anti-Injunction Act, 26 U.S.C. 7421(a) (2006), bars the action. Second, if the Court does reach the merits, it may uphold the constitutionality of the minimum coverage provision by relying on either the Commerce Clause or the Necessary and Proper Clause (or both), in which case it could decline to say anything about the constitutional scope of the tax power. 23 See generally Cooter & Siegel, supra note 4. 8

9 I. HISTORY A. Pre-Ratification The Articles of Confederation created a form of government that often impeded the states from acting collectively to accomplish common objectives. 24 The structure of governance established by the Articles posed two obstacles to collective action. First, the Articles authorized little federal power and imposed a unanimity requirement in order to amend the Articles. 25 Thus, significant federal action required unanimous agreement among the states. A single holdout state legislature could defeat measures that were deemed critically important by most other states. A key instance of collective inaction was the repayment of the debts of the United States. A pressing need during the 1780s was to repay public debts incurred by the United States during the Revolutionary War in order to restore public credit. 26 Without public credit, the nation would be vulnerable militarily because it could not borrow from other nations again in order to finance future wars. 27 To repay existing debts, a federal impost (that is, a five percent tax on imports) was proposed three times in Congress. These proposals were modest in their ambitions. Rather than recommend a general federal power to tax, [t]he 1781 and 1783 proposals to give the national government the 5 percent impost would have limited use of the revenues collected to the payment of the debts of the Revolutionary War. 28 Nothwithstanding the modesty of these 24 RAKOVE, supra note 5, at 24 28, 47 48, , , (discussing various failures of the Articles of Confederation). Almost all of the first thirty-six essays in The Federalist are devoted to the various inadequacies of the Articles. 25 See ARTICLES OF CONFEDERATION OF 1781, art. XIII. 26 See generally JOHNSON, supra note 6; AMAR, supra note 7, at 107 ( The vast bulk of preexisting continental debt came from the Revolutionary War.... ); BROWNLEE, supra note 3, at 16 ( Among the most pressing [practical problems] were how to finance the Revolutionary War debts, and how to establish the credit of the nation in a way that would win respect in international financial markets. ). 27 AMAR, supra note 7, at 107 (observing that Clause 2 of Section 8, which gave Congress the power to borrow money, surely contemplated the possibility of future wars ). 28 JOHNSON, supra note 6, at 89. 9

10 proposals, they did not survive the unanimity requirement of the Articles. Each time, a different state vetoed the measure. 29 Second, Congress under the Articles had to ask the states to control individual behavior, rather than Congress enacting statutes directly controlling individuals. Thus Congress could apportion taxes among the states, but levying and collection from individuals were left to state governments. 30 The Articles forced the federal government to finance itself by requisitioning the states. The amount per state was set in proportion to the value of all land within each State. 31 State governments, however, defaulted on congressional requisitions, free riding on the contributions of other states to the United States treasury. 32 The predictable consequence was very little federal revenue. 33 For example, the Requisition of 1786, the last before the Constitution, mandated payments by the states... of $3.8 million, but collected only $ The requisition scheme plagued Congress s efforts to pay and equip troops for the national military. 35 The need to rely on the states denied Congress the resources it needed to protect against external attack and internal violence. As a result, the nation almost lost the Revolutionary War The 1781 impost proposals were vetoed first by Rhode Island and then by Virginia. The 1783 impost proposal was vetoed by New York. 30 ARTICLES OF CONFEDERATION OF 1781, art. VIII. 31 Id. 32 See generally ROGER H. BROWN, REDEEMING THE REPUBLIC: FEDERALISTS, TAXATION, AND THE ORIGINS OF THE CONSTITUTION (1993) (describing the failure of the requisition scheme). 33 See, e.g., BROWNLEE, supra note 3, at 15 ( The Continental Congress depended on funds requisitioned from the states, which usually ignored calls for funds or responded very slowly. There was little improvement under the Articles of Confederation. States resisted requisitions and vetoed efforts to establish national tariffs. ). 34 See JOHNSON, supra note 6, at AMAR, supra note 7, at 45 ( Experience had proved that the individual states could not be trusted to provide their fair share of American soldiers and the money to pay for them.... ). Under the Articles, Congress could only requisition the states for their quota[s] of men, which was based on their white populations. To pay for the men and their equipment, Congress had to rely on a quota system based on wealth. Id. at Id. at ( The requisition system failed miserably and came perilously close to handing victory to the British in the Revolutionary War. With inadequate mechanisms to enforce states obligations, many states held back, hoarding resources for local defense despite more urgent need for them elsewhere on the continent. ). 10

11 In his Vices of the Political System of the United States, 37 a memorandum he wrote while preparing for the Constitutional Convention, 38 James Madison recorded various problems with the Articles of Confederation. These problems included the failure of states to comply with congressional requisitions, lack of concert despite common interests, lack of federal protection of the states against internal violence, and lack of coercive power. 39 Madison further decried the inability to pass various necessary measures, wch. may at present be defeated by the perverseness of particular States whose concurrence is necessary. 40 The states acted individually when they needed to act collectively. These collective action failures are what made the Critical Period critical. Solving them was the principal reason for calling the Constitutional Convention. The problems of collective action among the states during the 1780s necessitated a government with many more powers than were possessed by Congress under the Articles including the great powers to tax, to raise and support armies, and to regulate commerce. 41 Ameliorating these problems also necessitated conferring authority to exercise these powers by acting directly on individual citizens. 42 The Philadelphia Convention produced, and the country ratified, what amounts to a Constitution of collective action in the text of Article I, Section 8. The eighteen clauses of Section 8 mostly concern collective action problems created by two kinds of spillovers: interstate 37 James Madison, Vices of the Political System of the United States, in JAMES MADISON: WRITINGS 69, (Jack N. Rakove ed., 1999) [hereinafter Vices Memo]. 38 See RAKOVE, supra note 5, at Madison, supra note 37, at Id. 41 Larry D. Kramer, Madison s Audience, 112 HARV. L. REV. 611, 619 (1999). State discrimination against interstate commerce was yet another major collective action problem facing the states during the 1780s that Congress was impotent to address. Madison thus decried want of concert in matters where common interest requires it, a defect... strongly illustrated in the state of our commercial affairs. How much has the national dignity, interest, and revenue suffered from this cause? Madison, supra note 37, at Kramer, supra note 41, at

12 externalities and national markets. 43 Clause 2 gives Congress the power to borrow Money on the credit of the United States, which would be as essential in the next war as it had been in the previous one. 44 Clauses 3 through 6 give Congress the power to combat various impediments to the successful operation of interstate markets. 45 Clauses 10 through 16 give Congress the power to internalize the externalities associated with providing for the common defense, establishing a postal network, and securing intellectual property rights. 46 And to solve what was probably the single most significant collective action failure during the Critical Period the problem of financing the national government Clause 1 empowers Congress to assess, levy, and collect taxes by bypassing the states and acting directly on individuals. 47 The Framers adopted a complete national government able to collect taxes from individuals so as to avoid military action that would amount to civil war. 48 Notably, the Constitution does not limit the tax power of Congress to the repayment of debts, even though repaying the Revolutionary War debts was the immediate problem solved by the General Welfare Clause. Rather than limit federal revenue to repayment of past debts, the Constitution also gives Congress the power to tax in order to provide for the common Defense and general Welfare. 49 In this way, the constitutional text indicates that Congress may use its plenary tax power in order to achieve at least some regulatory ends that promote the general Welfare. 43 See Cooter & Siegel, supra note 4, at (analyzing the eighteen clauses of Article I, Section 8). 44 See supra note 27 (quoting Akhil Amar). 45 Cooter & Siegel, supra note 4, at Id. at See BROWNLEE, supra note 3, at 16 ( The fundamental structure of the federal tax system, as well as that of modern tax regimes, emerged from the formative emergency for the American federal government the revolutionary crisis that extended through the formation of the U.S. Constitution. ). 48 JOHNSON, supra note 6, at U.S. CONST. art. I, 8, cl

13 B. Post-Ratification Congress immediately raised revenues and changed behavior through tariffs. In the first two decades under the new Constitution, customs generated more than ten times the amount of federal revenue than did internal revenue. 50 In 1792, for instance, internal revenue was $209,000 and customs produced $3,443, And between 1789 and 1815, the tariff revenues accounted for about 90 percent of total federal tax revenues. 52 The Founders understood that import duties would not only raise revenues, but would also change the behavior of those subject to them. Like raising revenues, stimulating domestic production of manufactured goods by reducing their importation was an important legislative purpose. Thus Alexander Hamilton, in his December 1791 Report on Manufactures to Congress, proposed tariffs to protect new industries and exemptions from tariffs for raw materials needed for industrial development. 53 Hamilton s defended such policies not only on revenue-raising grounds, but also on the regulatory ground that they would encourage Americans to spend their money and energy to advance industrial technology. 54 As it turned out, Congress rejected most of Hamilton s program for industrialization. But in March 1792, Congress enacted most of the tariff program he had recommended: increases in tariffs on manufactured goods, including the iron and steel of Pennsylvania, and reductions in tariffs on raw materials www2.census.gov/prod2/statcomp/documents/ct1970p2-12.pdf. Table Y covers and distinguishes between customs and internal revenue. See BROWNLEE, supra note 3, at ( [T]he tax regime that followed the creation of the new constitutional order was based on customs duties; it lasted until the Civil War, making it the longest in American history. ). The Federalists made only limited use of excise taxes after the Whiskey Rebellion of 1794, limiting them almost entirely to goods and services used by affluent Americans, such as levies on carriages and snuff manufacturing, and stamp duties on legal transactions. See BROWNLEE, supra note 3, at Id. 52 BROWNLEE, supra note 3, at See, e.g., id. at Id. 55 Id. 13

14 In the subsequent course of American history, taxes were used for the dual purposes of raising revenues and dampening behavior. For example, Congress made a rare and temporary deviation from low tariffs in the antebellum period when it experimented with protectionism during the 1820s and 1830s. The rationale for high tariffs was not the need to raise additional revenues. The rationale, rather, was industrialization protecting America s high-wage workers and high-cost industries as they learned how to meet their British competition. 56 Likewise, the Civil War tax regime, which was instituted by the Republican Party, consisted principally of high tariffs, which sought to achieve the regulatory objective of encouraging a national market in which wages and profits were high. 57 The federal government had committed itself not merely to raising revenues, but to protecting capitalists and workers. Taxation served regulatory purposes after the Civil War, in the late 1860s and 1870s. The Republican-controlled Congress maintained high excise taxes on alcohol, tobacco, and luxury items such as perfumes and cosmetics. The public supported this system of consumption taxes partly because of its regulatory dimensions. 58 It amounted to a stunning victory for economic protectionism and, more generally, for government regulation through taxation. In sum, the system established tax incentives, disincentives, and subsidies as important, popular, and permanent elements of the federal revenue structure. 59 The leaders of American business lauded the regulatory effects of the tariff system, including the protection from foreign competition and the tendency of a favorable trade balance abroad to encourage capital formation at home. 60 The financial community was attracted to the Id. at Id. at 245; see id. at 5, 31. This regime also imposed excise taxes on almost all consumer goods. Id. at 58 Id. at Id. 60 Id. at

15 way in which substantial taxes on consumption forced national savings and facilitated repayment of the wartime debt. 61 Labor also supported high tariffs to stimulate the industries in which they worked and to protect them from low-wage labor in other parts of the world. Labor support for the high-tariff position of the Republican Party had much to do with its smashing victory in the critical election of 1896 and its strong electoral displays, which continued until the Great Depression. 62 After 1900, reformers sought taxes to regulate individual and corporate conduct. Mindful of the effects of past taxes on alcohol and tobacco, progressives used the federal tax power to regulate grain and cotton futures, the production of white phosphorous matches, the consumption of narcotics, and even the employment of child labor. 63 The tax historian W. Elliot Brownlee argues that America shifted to new tax regimes in response to national crises. 64 The eighteenth century saw the constitutional crisis of the critical period, which produced the plenary federal tax power. The nineteenth century saw the Civil War, which produced high tariffs that survived the war. The twentieth century saw three crises World War I, the Great Depression, and World War II. In each case, the federal government responded by using the tax power to raise revenues and regulate behavior. Threats to existence make people think about their reason for being. 65 What is the nation s purpose? Who are we as a people? American fiscal crises generated divisive debates over fundamental national values. The winners enforced their values partly by using the tax power to regulate behavior, not simply to raise revenues. In response to World War I, the 61 Id. at Id. at Id. at 45 n. 26 (citing R. ALTON LEE, A HISTORY OF REGULATORY TAXATION (1973)). 64 Id. at National leaders faced issues that went far beyond the financial problem of meeting demands to increase government spending. Id. at 2. These crises involved either the survival of the nation or the meaning of the American ethos, our fundamental nature as a people. Hanna Fenichel Pitkin, The Idea of a Constitution, 37 J. LEGAL. EDUC. 167, 167 (1987). 15

16 government attempted to reduce social tensions over wealth inequality by imposing progressive taxes to finance the war. During this period, federal tax policy discouraged vast accumulations of wealth by taxing excess profits and incomes, and by taxing large estates. 66 The federal government responded to the Great Depression by assuming greater responsibility to promote economic recovery through such fiscal mechanisms as cutting taxes, increasing expenditures, and expanding deficits. 67 The World War II regime defended mass-based income taxation in terms of not only sacrifice for national survival but also progressive social justice. 68 After World War II, inflation and progressive tax rates automatically increased potential tax revenues. Potential revenues were dispersed partly by tax expenditures, a phrase referring to exclusions, deductions, and credits that create narrow exceptions in a broad tax. Tax breaks encounter less public resistance than government subsidies because they are hidden in the tax code instead of being exposed in the budget. Tax expenditures allowed politicians to accomplish regulatory objectives such as promoting homeownership through the mortgage-interest deduction without subjecting themselves to the greater transparency of federal expenditures. 69 More recently, Presidents Ronald Reagan and George W. Bush justified significant tax cuts, including on the wealthiest Americans, as enhancing economic productivity. 70 These Presidents echoed the rhetoric and actions of Republicans during the 1920s, when they used control of the federal government to cut taxes and open loopholes for corporations and wealthy individuals. 71 Republicans justified these reductions, exemptions, and deductions as necessary to stimulate economic expansion and restore prosperity BROWNLEE, supra note 3, at Id. at Id. at 245; see id. at Id. at Id. at Id. at Id. at

17 While the two major political parties often disagree about the regulatory objectives that federal tax policy should pursue, they agree that federal tax policy aims to accomplish regulatory objectives in addition to raising revenues. Brownlee concludes a history of federal taxation in the United States by observing that [h]istorically, the introduction of new tax regimes that enhance confidence in American government has required, among other things, regulation of behavior in ways that were widely regarded as improving the national well-being. 73 The text of the Constitution and political history suggest that Congress possesses ample power to regulate individual behavior by using its tax power. Text and history do not identify limits on the regulatory ends that Congress may pursue by the means of taxes. The text of Article I, Section 8 uses the language of both taxation and regulation, and it does not use them interchangeably, which suggests that they are not entirely synonymous. The next Part reviews the Supreme Court s attempts to distinguish them. II. DOCTRINE At various times throughout American history, the Supreme Court has addressed the constitutional definition of Taxes in the first clause of Article I, Section 8. Roughly speaking, the Court s decisions divide into three eras, which point the way towards a theory of the constitutional differences between taxes and the regulations. A. Three Eras The Introduction distinguished between exactions that prevent behavior and exactions that both dampen it and raise revenue. Before the 1920s, the Court deferred to Congress and did not make such distinctions. Thus in Veazie Bank v. Fenno, the Court upheld a federal law that 73 Id. at

18 increased a tax on state bank notes from one percent to ten percent, even though the primary purpose of the tax was to eliminate the state notes. 74 Similarly, in McCrary v. United States, 75 the Court upheld a federal law that increased the excise tax from two cents to ten cents on oleomargarine that was colored yellow to make it look like butter. (The tax on uncolored oleomargarine, which is white, remained one-quarter of a cent per pound.) The Court rejected the argument that the exaction was a penalty primarily intended to achieve regulatory objectives. Because the taxing power conferred by the Constitution knows no limits except those expressly stated in that instrument, it must follow, if a tax be within the lawful power, the exertion of that power may not be judicially restrained because of the results to arise from its exercise. 76 Likewise, in United States v. Doremus, 77 the Court upheld the Narcotic Drug Act of 1914, which both taxed narcotics and regulated their sale. If the legislation enacted has some reasonable relation to the raising of revenue, the Court wrote, it cannot be invalidated because of the supposed [regulatory] motives which induced it. 78 The doctrine changed during the Lochner Era. In Hammer v. Dagenhart, the Court held that Congress held may not use its commerce power to prohibit the shipment in interstate commerce of goods produced by child labor. 79 Congress responded with the Child Labor Tax Law, which provided that individuals employing child labor shall pay for each taxable year, in addition to all other taxes imposed by law, an excise tax equivalent to 10 per centum of the entire net profits received or accrued for such year from the sale or disposition of the product of such U.S. (8 Wall.) 27 (1869) U.S. 27 (1904) 76 Id. at U.S. 86 (1919). 78 Id. at U.S. 251 (1918). 18

19 mine, quarry, mill, cannery, workship, factory, or manufacturing establishment. 80 The law further authorized a federal inspection regime, interference with which was made subject to fine or imprisonment. 81 The law exempted employers from liability for the exaction in cases of a child employed or permitted to work under a mistake of fact as to the age of such child and without intention to evade the tax. 82 The Child Labor Tax Case 83 invalidated the law. 84 Writing for the Court, Chief Justice Taft distinguished exactions that the Constitution authorizes under the tax power from penalties, which the tax power does not authorize. He stated that taxes have only that incidental restraint and regulation which a tax must inevitably involve. 85 Taxes, he elaborated, are occasionally imposed in the discretion of the Legislature on proper subjects with the primary motive of obtaining revenue from them and with the incidental motive of discouraging them by making their continuance onerous. 86 of the incidental motive. 87 On this view, [t]hey do not lose their character as taxes because He insisted, however, that there comes a time when an exaction amounts to a penalty. 88 This is when, in the extension of the penalizing features of the so-called tax... it loses its character as such and becomes a mere penalty with the characteristics of regulation and punishment Bailey v. Drexel Furniture Co., 259 U.S. 20, 35 (1922). 81 Id. 82 Id. 83 Bailey v. Drexel Furniture Co., 259 U.S. 20 (1922). 84 Id. at 37 ( [A] court must be blind not to see that the so-called tax is imposed to stop the employment of children within the age limits prescribed. Its prohibitory and regulatory effect and purpose are palpable. All others can see and understand this. How can we properly shut our minds to it? ); id. at 39 ( The case before us cannot be distinguished from that of Hammer v. Dagenhart. (citation omitted)). 85 Id. at Id. at Id. 88 Id. 89 Id. Accord United States v. Butler, 297 U.S. 1, 61 (1936) ( A tax, in the general understanding of the term, and as used in the Constitution, signifies an exaction for the support of the government. The word has never been thought to connote the expropriation of money from one group for the benefit of another. ); id. (The exaction cannot be wrested out of its setting, denominated an excise for raising revenue and legalized by ignoring its purpose 19

20 Turning to the child labor statute, Chief Justice Taft concluded that it regulate[s] by use of the so-called tax as a penalty because it provides for a heavy exaction for a departure from a detailed and specified course of conduct in business, and because [s]cienters are associated with penalties, not with taxes. 90 The Chief Justice noted that the statute does not explicitly prohibit child labor, but it does exhibit its intent practically to achieve [this] result by adopting the criteria of wrongdoing and imposing its principal consequence on those who transgress its standard. 91 The Chief Justice feared that recognizing such a penalty as a tax for constitutional purposes would end judicially enforceable limits on Congress s enumerated powers. 92 The exaction sounded like a tax and worked like a penalty, and the Court struck it down because materiality dominated expression in its constitutional interpretation. 93 Other decisions from the Lochner Era similarly distinguished regulatory exactions, which the Court deemed to be penalties, from revenue-raising exactions, which the Court regarded as taxes. In Hill v. Wallace, the Court invalidated a federal exaction on grain future contracts, which would be imposed unless a board of trade recognized by the U.S. Department of as a mere instrumentality for bringing about a desired end. To do so would be to shut our eyes to what all others than we can see and understand. (citing Child Labor Tax Case, 259 U.S. at 37)). 90 Id. at Id. at The Court wrote that if the exaction at issue was a tax, then Congress could regulate all private behavior: Grant the validity of this law, and all that Congress would need to do, hereafter, in seeking to take over to its control any one of the great number of subjects of public interest, jurisdiction of which the states have never parted with, and which are reserved to them by the Tenth Amendment, would be to enact a detailed measure of compete regulation of the subject and enforce it by a so-called tax upon departures from it. To give such magic to the word tax would be to break down all constitutional limitation of the powers of Congress and completely wipe out the sovereignty of the states. Id. at Id. at 39 ( Congress in the name of a tax which on the face of the act is a penalty seeks to do the same thing, and the effort must be equally futile. ); ( [T]he so-called tax is a penalty to coerce people of a state to act as Congress wishes them to act in respect of a matter completely the business of the state government under the federal Constitution. ). 20

21 Agriculture approved the contracts. The Court viewed the exaction as a penalty and not a tax. 94 In United States v. Constantine, the Court invalidated a federal exaction on liquor dealers who had violated state liquor laws on the ground that the exaction exhibits... an intent to prohibit and to punish violations of state law [and thus to] remove all semblance of a revenue act, and stamp the sum it exacts as a penalty. 95 After the constitutional crisis of 1937, 96 the Court did not formally overrule the Child Labor Tax Case and related decisions. The same is true of other Lochner Era precedents that have long since been abandoned, including Lochner itself. 97 Courts, commentators, and litigants presently disagree about whether the Court s tax power decisions from the 1920s and 1930s remain good law. 98 They agree, however, that the Court deferred to Congress when interpreting the tax power in the decades after Thus in Sonzinsky v. United States, the Court upheld as within the scope of the General Welfare Clause a $200 annual license tax on firearms dealers U.S. 44 (1922). 95 United States v. Constantine, 296 U.S. 287 (1935). 96 See, e.g., ALEXANDER M. BICKEL, THE LEAST DANGEROUS BRANCH: THE SUPREME COURT AT THE BAR OF POLITICS 45 (1962) ( Serving this value [of laissez faire] in the most uncompromising fashion, at a time when it was well past its heyday, five Justices, in a series of spectacular cases in the 1920 s and 1930 s, went to unprecedented lengths to thwart the majority will. The consequence was very nearly the end of the story. ). For a recent account of the political fight over President Franklin Delano Roosevelt s court-packing plan, see generally JEFF SHESOL, SUPREME POWER: FRANKLIN ROOSEVELT VS. THE SUPREME COURT (2010); see also BARRY FRIEDMAN, THE WILL OF THE PEOPLE: HOW PUBLIC OPINION HAS INFLUENCED THE SUPREME COURT AND SHAPED THE MEANING OF THE CONSTITUTION 3 8, 202, 214, (2009). 97 Compare, e.g., Lochner v. New York, 198 U.S. 45 (1905), with West Coast Hotel Co. v. Parish, 300 U.S. 379, 391 (1937) ( What is this freedom of contract? The Constitution does not speak of freedom of contract. ). See Richard A. Primus, Canon, Anti-Canon, and Judicial Dissent, 48 DUKE L.J. 243, 244 (1998) ( Lochner is never cited for its legal authority. Although it has never been formally overruled, it is well understood among constitutional lawyers that relying on Lochner would be a pointless, if not a self-destructive, endeavor. ). 98 Compare, e.g., Thomas More Law Ctr. v. Obama, --- F.3d ---, 2011 WL , at *33 (6th Cir.) (Sutton, J., concurring in part and delivering the opinion of the court in part) ( The taxing-power cases, it is true, are old. Yet cases of a certain age are just as likely to rest on venerable principles as stale ones, particularly when there is a good explanation for their vintage. ), with, e.g., Brian Galle, Conditional Taxation and the Constitutionality of Health Care Reform, 120 YALE L.J. ONLINE 27, 28 (2010), ( [T]he best reading [of existing doctrine] is that courts will not impose any substantive limits on the uses to which Congress may put its taxing authority. Any confusion results from the Court s failure to formally overrule outdated precedents that once suggested otherwise. ) U.S. 506 (1937). 21

22 The Court rested on the ground that exactions with regulatory effects are still taxes if they appear to have been imposed pursuant to the tax power: Every tax is in some measure regulatory. To some extent it interposes an economic impediment to the activity taxed as compared with others not taxed. But a tax is not any the less a tax because it has a regulatory effect, and it has long been established that an Act of Congress which on its face purports to be an exercise of the taxing power is not any the less so because the tax is burdensome or tends to restrict or suppress the thing taxed. 100 The Court declared that [i]nquiry into the hidden motives which may move Congress to exercise a power constitutionally conferred upon it is beyond the competency of courts. 101 It was enough for the Court that the tax is productive of some revenue and operates as a tax. 102 The Court went even further in United States v. Sanchez, 103 declaring that an exaction is a tax even if it prevents the activity and raises little or no revenue. It is beyond serious question, wrote the Court, that a tax does not cease to be valid merely because it regulates, discourages, or even definitely prevents the activities taxed. 104 Moreover, the principle applies even though the revenue obtained is obviously negligible, or the revenue purpose of the tax may be secondary. 105 Since Sanchez, the Court has repeatedly refused to invalidate exactions on the ground that Congress was using the taxing power to regulate conduct. For instance, in United States v. 100 Id. at Id. at , 102 Id. at U.S. 42 (1950). 104 Id. at Id.; see id. ( Nor does a tax statute necessarily fall because it touches on activities which Congress might not otherwise regulate. ). It was settled long ago that the power of Congress to regulate conduct through taxation (or conditional expenditures) under the General Welfare Clause is not limited to regulation that is otherwise permissible under another enumerated power. See License Tax Cases, 72 U.S. (5 Wall.) 462, (1867) (upholding under the tax power a federal law requiring the purchase of a license before engaging in certain businesses, including intrastate businesses, even though Congress has no power of regulation nor any direct control over the internal commerce or domestic trade of the States ); United States v. Butler, 297 U.S. 1 (1936); United States v. Sanchez, 340 U.S. 42, 44 (1950) ( Nor does a tax statute necessarily fail because it touches on activities which Congress might not otherwise regulate. ). This principle is not being challenged in the constitutional litigation over the Affordable Care Act. See infra Part IV. 22